Is Gold No Longer A Safe Haven? Not According To Capital Economics: “Gold Will Surge When Euro Crisis Escalates”

With gold dropping $200 in the past several weeks on ongoing much anticipated liquidations to cover margin calls, there are those who have wondered if the precious metals have lost their safe haven luster? Well, no. All they have lost is some value against the dollar even as all other global currencies have fallen faster than even gold as was pointed out yesterday by Mike Krieger[2]. In other words all that is happening is a relative devaluation of the DM currencies relative to the one absolute, and to the dollar as well. However, as the Swiss National Bank so aptly demonstrated, all it takes for a central bank to intervene drastically is for its currency to appreciate beyond reasonable parameters. Which is what is happening to the dollar, not due to some intrinsic value in the currency, because it is just a matter of months if not weeks before Bernanke is forced to print all over again. The only reason the USD is soaring is due to to a multi-trillion dollar funding shortage around the world but mostly in Europe, which the Fed hopes to satisfy with a massive expansion in FX swap lines which become activated on October 12 but not before. Either way, some of the more timid elements may be explainably rushing for cover to paraphrase Norville Barnes. Which is why we present the following report from Capital Economics which explains why “Gold still deserves “safe haven” status.”

From Capital Economics

Gold still deserves “safe haven” status

• The recent sharp falls in the dollar price of gold have led some to question its status as a refuge from problems elsewhere, especially now that the US currency is strengthening across the board. However, if (or when) there is a further escalation in the crisis in the euro-zone, gold prices are still likely to surge against the dollar too.

• The price of an ounce of gold has now fallen by more than $200 from the record nominal highs above $1,900 seen earlier in the month. Since Tuesday alone, gold is down more than $100. As the price of traditionally riskier assets such as equities and industrial commodities have also fallen sharply over this period, it is tempting to conclude that gold has become another casualty of the “risk-off” trade.

• Despite this, we continue to expect gold to rise above $2,000 this year and to at least $2,500 no later than 2013. The fundamentals that support gold’s status as a safe haven have not of course changed in the last few days. Above all, its value does not depend on the creditworthiness of any government or financial institution, and that may yet prove very significant in the weeks and months ahead.

• What’s more, with gold prices now at previously unprecedented levels, the absolute size of daily moves are likely to be larger – both up and down. Despite the recent falls, the gold price is still nearly $100 higher than at the start of August.

A d v e r t i s e m e n t

• Finally, the recent fall in the dollar price of gold primarily reflects a return of a degree of confidence in the US currency, which may not be sustained. The price in euro terms, for example, has held up a little better, which is what matters more for European investors seeking protection from the crisis in the euro-zone. (See Chart 1.) Other things being equal, a stronger dollar does imply a lower gold price when measured in dollars. This is partly because of the simple pricing effect which applies to any commodity, whereby purchasers in other currencies can afford to pay a higher price in dollars when the dollar is weak. But gold is also seen as a close substitute for the dollar as a store of value, so if there are doubts about the prospects for the US currency, gold tends to benefit disproportionately.

• The reverse appears to have happened recently. Crucially, the markets have moved on from the dispute over the US debt ceiling and the loss of the AAA rating (with S&P). The Fed’s reluctance to adopt further quantitative easing has also allowed the dollar to regain some of its own safe haven status.

• Nonetheless, in the event of a disorderly Greek default, and particularly if fears of a break-up of the euro-zone really take hold, gold is still likely to benefit more than any other currency even if the dollar proves to be the best of the rest. In part this is because the upside for gold is not constrained by broader economic and policy considerations, whereas the value of the dollar (and of other national currencies such as the yen and sterling) clearly is. Confidence in the dollar is also likely to be undermined again by the fall-out from fresh euro-zone shocks on the US economy and banks. Indeed, since the global crisis began there have been several periods when the dollar has generally been strengthening and yet the price of gold in dollar terms has risen further, such as the second quarter of 2010 when concerns about Greece took off. (See Chart 2.) Although gold prices are now much higher, there is no good reason to rule out a repeat out-performance if the crisis in the euro-zone takes an even more sinister turn.